IFRS 17 implementation Practical issues and challenges so far. Rokas Gylys Baltic Actuarial Summer Days 2018

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1 IFRS 17 implementation Practical issues and challenges so far Rokas Gylys Baltic Actuarial Summer Days 2018

2 Brief overview of IFRS17 Major change in accounting rules for insurance contracts IFRS 17 will not be applied to investment contracts although unbundling rules will change. Effective from 1 January 2021 Insurance contract liabilities will be more similar to Solvency II technical provisions, but not the same Complex transition rules The impact on financial results and equity still needs to be assessed (depends on the accounting model/ transitional options selected) Major impact on systems (data, valuation, reporting)

3 Accounting/ measurement models Source: PwC, In depth, A look at current financial reporting issues, IFRS 17 marks a new epoch for insurance contract accounting

4 Direct participation feature/ VFA VFA reduces the volatility of results compared to BBA s Participating contracts are products where pool of policyholders has the legal right to the pre-defined share of surplus however the rules for individual contract maynot be fixed Criteria to determine whether VFA approach can be applied ( direct participation ) Insurers share in profit is accounted as CSM Changes in the estimates of future fees adjusted against CSM. In calculations of liabilities for different groups of policies will be possible to move expected bonuses between groups without affecting the PL or CSM Obligation to policyholder Benefits based on underlying assets Minus variable fee i.e. charge of the company

5 Challenge No 1. Decide on the portfolios and measurement models Review classification to insurance and investment contracts Discretionary participation feature Direct participation feature Separation of components Grouping of contracts

6 IFRS17 classification tree IFRS17, VFA Contains direct participation feature? IFRS17, BBA or PAA Significant insurance risk? IFRS17, BBA or VFA* Contains discretionary participation feature? IFRS9, IFRS15 *if the company also issues insurance contracts

7 PAA eligibility criteria Basis for PAA premiums received less acquisition costs Option to expense acquisition costs for groups of contracts with coverage period 1 year Adjustment for discounting if there is a significant financing element Coverage period 1 y.? PAA can be applied PAA result similar to BBA? PAA can be applied Losses for onerous groups should be recognized immediately BBA Incurred claims provisions still under BBA, but discounting is not mandatory if CF 1 year.

8 Open questions to consider Will the previous benchmarks for significance of insurance risk will hold? What about products with profit sharing, where policy conditions do not specify the profit sharing proportions? Is the link to FV returns enforceable? Can such product meet the definition of DPF or DiPF? Can long term pure risk life insurance qualify for PAA? If yes, what supporting analysis should be performed?

9 Separation of components Distinct investment components Distinct service component Embedded derivatives Separation of different insurance covers?? (currently under discussion in TRG)

10 Distinct investment component Entity should separate from a host insurance contract an investment component if, and only if, that investment component is distinct Investment component is distinct if: Not highly unrelated with insurance component: can be measured separately, policyholder is unable to benefit form one component unless other is present Contract with equivalent terms is sold or could be sold in the market No more unbundling option, which was often applied in the Baltics

11 Example Question: Does unit linked contract with risk riders contain distinct investment component? Answer: No, as highly interrelated. Normally in case of termination of insurance part, investment part is also terminated (and vice versa). See Illustrative Example No 4.

12 Grouping at initial recognition Source: KPMG, Insurance Contracts, First Impressions IFRS 17

13 Grouping open questions Determining the factors to use in determining the profitability groups, e.g.: - Non standard pricing - Client segment - Distribution channel - Etc. Exemption where law or regulation impact the ability to price separately (e.g. EU unisex pricing requirements). Is internal reporting always available to determine the profitability groups? How the companies should proceed if this is not the case? How to set a threshold for profitable/ highly profitable groups?

14 Challenge No 2. Update the measurement model Contract boundaries and CF projections Discount rates Risk adjustment CSM

15 Initial recognition - BBA Cash In Cash Out Discounting Risk Adjustment Contractual service margin

16 Contract boundaries Cash flows are within the contract boundary if Entity can compel the policyholder to pay premiums or Has a substantive obligation to provide the policyholder with services This substantive obligation ends when: Entity has the practical ability to reassess the risks of the particular policyholder and can set the price that fully reflects these risks or Both conditions are met: Entity has the practical ability to reassess the risks of the portfolio that contains the contract and can set the price that fully reflects these risks The pricing of the premiums for coverage up to the reassessment date does not take into account risk that relate to periods after the reassessment date

17 CF projections Similar to Solvency II, however, there are exceptions: Boundaries of cash flows Acquisition costs General overheads Contracts with profit sharing ( Mutualisation ) Other?

18 Open questions One boundary approach. Still discussed in TRG. Could have major implications for direct business and reinsurance contracts held Determining directly attributable expenses to be included in CF projections

19 Valuation interest rate Discount rates should reflect the nature of cash flows Illiquidity premium should be included in the discount rate Top-down or bottom-up approach. Can EIOPA risk free interest rate be used as the basis? What would be a practical approach to derive illiquidity premium?

20 Risk adjustment No prescribed method, examples: Confidence level Cost of capital Cost of capital method might be considered, however: Confidence level should be disclosed How to derive/ justify cost of capital rate?

21 CSM calculations The key implementation question is how to determine coverage units of a group of contracts for the purpose of release of CSM. BC rejected the pattern of expected CF as the basis for allocation of CSM to reporting periods Ongoing discussion at TRG on this matter CSM calculation will require separate tool and data storing capacity In BBA historic discount rates are use for interest accretion - additional data storing requirement.

22 Other challenges Assessment of financial impact and available options Changes in financial reporting systems and processes Align new KPI, KRIs, management reporting Data availability and storing Disclosures Transitional calculations Training and employees and management

23 Thank you for the attention! We ll have a lot of materials to read in the next 2 years

24 Disclaimer The views expressed in this presenatation are my own and do not necessarily represent the views of SEB. This content is for educational/ general information purposes only and cannot replace a professional advice. Most of the IFRS17 rules are still discussed and subject to further interpretation and possible changes.